BioCycle July 2007, Vol. 48, No. 7, p. 66
Power purchase agreements, an assured fuel supply, and a commitment from the project’s sponsors in terms of time, sweat equity and cash are key to “making a deal.”
Diane Greer

A mountain of wood chips, a forest filled with charred trees and tons of waste from a recycled paper plant will supply the fuel. Two Arizona utilities have agreed to purchase the electricity. Local, state and federal authorities have issued applicable permits. Construction of Arizona’s largest biomass facility is finally underway.
When completed in early 2008, the Snowflake White Mountain Power (SWMP) plant located 130 miles northeast of Phoenix, Arizona, will generate 24 MW of electricity from biomass. The developer, NZ Legacy based in Mesa, Arizona, proposed building SWMP in 2004. It took nearly two years of sustained effort by the development team to close on $53 million of financing for the plant.
Meanwhile, developers are hoping to finalize financing on the 200 MW South Point Biomass Project (SPBP) in South Point, Ohio this summer. Biomass Group, LLC, the developer based in Nicholasville, Kentucky, started working on the project back in 2003.
Both of these projects illustrate the time and effort required to secure funding for biomass power projects. Financing a biomass power facility is definitely not for the faint of heart. “Project financing is a tough thing to do,” says Mark Harris, lead developer and President at Biomass Group. “You have to have all the pieces and the planets lined up.”
The article marks the first in an occasional BioCycle series, Anatomy Of The Deal. Tools and strategies used by project developers to secure funding are a key part of building a renewable energy from organics recycling infrastructure.
SECURING REVENUES
Both NZ Legacy and Biomass Group are employing nonrecourse project finance to fund their plants. Under this type of financing, the revenues (cash flow) generated by the project are used to pay back the debt and provide a return to the equity investors. “One of the first priorities in financing a power project is to lock in a revenue stream so you can go to the bank,” says Keith Martin, partner in Project Finance at Chadbourne & Parke.
Securing revenues for SWMP began in 2003 with an RFP for 10 MW of biomass power issued by Salt River Project (SRP), one of Arizona’s largest utilities. SRP had set a goal to obtain two percent of its power from renewable sources. The utility is exempt from Arizona’s Renewable Energy Standard (RES) mandating regulated utilities get 15 percent of their electricity from renewables by 2025.
NZ Legacy won the SRP bidding process in September 2004 with a proposal to build the SWMP project adjacent to the Abitibi Paper Mill near Snowflake, Arizona. Realizing the project’s economics improved if the plant’s scale was increased, the developers subsequently approached Arizona Public Service (APS), which is subject to the state’s RES, to purchase an additional 10 MW of power, explains Scott Higginson, Executive Vice President of NZ Legacy. The remaining power produced by the facility will be used on site.
Thomas Suffield, Principal at Cedars Capital and SWMP financial advisor, negotiated both power purchase agreements (PPAs). The SRP agreement purchases 10 MW of power for 15 years and 20 MW of power for the succeeding five years. APS is buying 10 MW of power for 15 years. The power will be sold under both PPAs for about 7.5 cents/kWh and both include escalation clauses for the life of the contract, Suffield says. The value of the RECs (Renewable Energy Certificate) is captured in the PPAs and goes to the utilities, he adds. “The RECs are required for the utilities to gain credit for using renewable power sources.”
FINDING FUEL
Fuel supply is another major concern when financing biomass facilities. Investors want to know how the fuel will be supplied and at what price over the term of the financing. In the case of SWMP, assuring investors of a long-term fuel supply was key.
SWMP will require 125,000 tons/year of biomass to feed bubbling fluidized bed boilers. One major fuel source is fire-damaged timber from Arizona’s largest wildfire, the Rodeo-Chediski fire, which scorched 469,000 acres. Additional wood waste will be supplied from forest thinning operations and regional sawmills.
The plant also will burn 250 tons/day of waste paper fibers from the Abitibi paper mill, which manufactures recycled paper from discarded paper and cardboard. That quantity of fibers is enough to fuel a 6 MW power plant. “Instead of going to a landfill, the waste fibers will be dewatered and burned at SWMP,” Suffield says.
Beyond fuel, colocating with Abitibi produced additional synergies. SWMP will use Abitibi’s 40 MW digital substation with interconnects to APS’s Cholla Power Plant via a 69KV-dedicated line to transfer power generated by the plant to the grid, Higginson says. The line can accommodate 42 MW of additional power and operates under an existing transmission agreement.
Available land at the facility includes a fire-protected chip yard previously used by the mill. “There is also a lot of infrastructure in place for moving wood,” Suffield says.
ASSESSING RISKS
CoBank, the lead arranger of the financing, viewed the PPAs and fuel supply sources as compelling elements of the project. “We wouldn’t have been interested in this opportunity had it not had strong off-take agreements [PPAs] with APS and SRP,” explains Dave Willis, CoBank Managing Director. “Secondly, the sponsor [NZ Legacy] had gone far down the path to secure the fuel supply.”
While long-term contracts existed between Abitibi and NZ Legacy for the waste paper fibers, only short-term contracts were available from the U.S. Forest Service for removal of waste wood from Arizona forests. To gain a level of assurance on the fuel supply, CoBank included a fuel assessment study as part of the requirements for the financing.
Fuel assessment studies identify and provide estimates of wood waste availability, quality and costs within a specified distance from a facility. The goal is to determine if sufficient wood waste is available well in excess of plant requirements. The study came back with the clear indication that there was sufficient fuel available to power the plant, Higginson says.
With both of these critical elements in place, CoBank concentrated its efforts on assessing the risks associated with building the plant, in addition to undertaking a thorough due diligence on technical, legal and insurance issues. In an ideal world, lenders prefer fixed-priced, turnkey engineering, procurement and construction (EPC) contracts when financing projects. In essence, lenders are seeking a single creditworthy construction contractor taking all the price risks and guaranteeing, upon completion of construction, that the sponsors can simply “turn a key” and everything will work as specified in the contract.
But obtaining fixed-priced, turnkey EPC contracts has become virtually impossible. Many of the creditworthy contractors taking on that kind of construction risk in the past were forced into bankruptcy when costs got out of control, Willis says. For smaller projects like SWMP, which uses new and used equipment, few parties are willing to accept the associated risks, he adds.
CoBank instead became comfortable with the construction risk through a due diligence process. “We wanted to understand who would perform the work, their level of experience and the form of their respective contracts, fixed-price or cost plus,” Willis says. “And if the contracts were cost plus, we wanted to know what the reopeners were that could result in a price increase.”
Based on an assessment of the degree of certainty in the project schedule and costs of various contracts, contingencies were built into the project budget. “We also have some undertakings from the project’s sponsor that would be called upon in the event the contingency is exhausted,” he adds.
Technology risks were another element of concern. SWMP realized cost savings by using a mix of new and used equipment, such as conveyors and screw presses, obtained from an idled paper facility in Houston, Texas. “One is never quite sure how a mix of new and used equipment can be married together and work perfectly in a plant,” Willis explains.
He ranked operating risk as a distant fourth in terms of concerns. Operators who run the coal-fired power plant at the Abitibi Paper Mill also will operate the SWMP plant. “There are enough similarities to running a coal plant and a biomass plant to think they should be capable of doing both,” Willis says.
Another significant factor was CoBank’s belief that the project’s sponsor, Robert Worsley, CEO of NZ Legacy, could get the financing closed, complete construction and successfully operate the plant over the long haul. Worsley is the founder and former CEO and president of SkyMall and has significant interests and relationships in Arizona.
Willis views Worsley as a strong and capable project sponsor: “Sponsorship on these more challenging projects is critically important. There has to be a real commitment in terms of time, sweat equity and cash.”
CLOSING THE FINANCING
Total cost for the project is about $70 million. This includes the cost of the plant as well as the cost of equipment to remove, transport and process wood wastes acquired from the forests by another NZ Legacy company, Renegy LLC.
The project closed on $53 million in debt financing in September 2006. CoBank provided $13.5 million in term debt with an 18-year maturity and the Show Low Industrial Development Authority issued $39.25 million in 18-year tax-exempt bonds, Suffield says. The project qualified for industrial development bonds because it was characterized as a solid waste disposal facility.
CoBank is providing letters of credit to support the issuance of the bonds. “The industrial development bonds could not have been issued at the price they were if CoBank had not posted a letter of credit to enhance the risk around those bonds,” Willis explains.
Industrial development bond investors need a rated institution backing the letter of credit. “Since CoBank does not have a public rating, JP Morgan Chase was brought in to wrap the guarantee for the tax-exempt investor,” Suffield explains. “The purchasers of the bonds do not take project risk. They are basically taking JP Morgan Chase credit risk.” Worsley contributed slightly under $20 million in cash equity as well as previously acquired equipment to fund the remainder of the project.
During the financing, the developers did not know if the project would qualify for production tax credits (PTC). Under federal law, closed-loop biomass projects qualify for a 1.9 cents/kWh tax credit for the first 10 years of operation. The law was set to expire before the plant could begin production, but was later extended through 2008.
“The project has favorable economics on a standalone basis,” Suffield says. “The PTCs essentially offer the project a nice upside.” Construction is currently underway with completion set for the first quarter of 2008.
IN THE WORKS
Financing the 200 MW South Point Biomass Plant (SPBP) in South Point, Ohio has not gone as smoothly as SWMP. The project was originally conceived as a 500 MW gas-fired, combined-cycle power plant but could not be financed due to the downturn in the merchant energy market, explains Rich Haddon, the project’s financial advisor and Executive Director at Pace Global Energy Services.
When considering other options for the site, Mark Harris, lead developer and President at Biomass Group, identified biomass power as a viable alternative in 2003. “He began to repermit the project and acquire contracts for the fuel,” Haddon says. “It has taken some time to get all the various parts and entities to come together.”
Part of the delays resulted from amendments to permits, which were required when the plant’s size was increased from 148 MW to 200 MW to improve project economics, Harris explains. SPBP will now cost $500 million and produce power fueled with 1.5 million tons/year of wood waste. The fuel supply comes from diverse sources including furniture manufacturers, small saw mills, tree trimming operations and municipalities.
The amount of fuel required to power the plant concerned some investors, who are wary after seeing fuel shortages plague previous biomass projects. To allay concerns, the developer engaged independent consultants to do a fuel assessment study and give an opinion on fuel supply contracts. “An independent consultant’s report verified the presence of wood waste far in excess of our needs. In addition, the consultant reviewed and verified our contractual arrangements to meet the fuel needs,” Haddon says.
ALLOCATING PRICE RISKS
Electricity generated at SPBP will be sold to PJM, which operates a wholesale electricity market in all or parts of 13 states and the District of Columbia. Demand for electricity in the region is strong, pushing prices up, Haddon says. He recently saw prices close to $50/MWh, although off-peak pricing is still in the $30s. “The actual dollars and dispatch price of wood-fired power is very competitive to coal,” he adds. “We expect the variable cost of dispatch to be in the $25-30/MWh range, which is very consistent with similar plants with fuel pricing in our current range.”
Long-term power purchase agreements are not an option when operating within a wholesale electricity market. To obtain funding, SPBP needed another means to secure a level of certainty on the price it receives for power generated by the plant. Discussions are currently underway with a financial institution that trades power to contract for a “fixed for floating price swap” for the electricity generated over a five to 10 year term. Under a swap, SPBP would contract with the financial institution for a fixed forward price for its electricity. Fluctuations in actual wholesale electricity price would result in gains for the financial institution when actual prices rise above the contracted price, or losses when they fall below.
In essence, the swap is allocating the price risk associated with the volatility of wholesale electricity prices to the financial institution, which is banking on its understanding of the market and price risks to come out ahead on the deal. The developers need the price certainty to obtain financing.
The project also received tentative letters of agreement from New Jersey and Pennsylvania qualifying the plant for Class I RECs and permitting the RECS to be sold on both markets. Both states have renewable portfolio mandates that are ratcheting upward. Haddon believes that by the time the plant is completed in 2010, the RECs will provide a significant amount of value to the project.
Negotiations are underway with a broker to market the RECs produced by the project. The agreement most likely will involve 50 to 100 percent of the RECs produced in the first five years of operations, and 50 percent for the next five years to support the financing.
Like SWMP, SPBP was unable to find a single EPC construction contractor. Instead, a proposal is under development to use a large construction company that will be responsible for the procurement, some of the engineering, and the construction of the plant. The remainder of the engineering will be subcontracted. There are also three contracts with equipment manufacturers. All engineering will be coordinated and run together in a package by an independent engineer to satisfy the bank’s requirements. The plant will install Stoker Grate Boilers.
Discussions are progressing with a provider of senior debt. The most likely scenario will be a financing package with 55 to 60 percent senior debt and the remainder subordinated debt and equity. The team is currently seeking a tax equity partner to take advantage of the large depreciation benefits. There could be additional tax benefits if the production tax credit (PTC) is extended beyond 2008. “The financing is not contingent on PTCs,” Haddon says. “Those are equity upsides.” The current plan is to complete plant financing by this summer and finish construction before the end of 2008. “So we would only need a one-year extension of the PTC,” he adds.